Yuan devalued again; China’s lack of communication confuses markets

FXStreet (Mumbai) - The People's Bank of China (PBOC) today once again guided the yuan lower, setting the official midpoint rate on the yuan at 6.5646 per dollar, the lowest since March 2011. Following the central bank’s decision to allow the currency a free flow, yuan plunged to a record low of 6.7511 against the dollar before recovering to 6.6910 on suspected intervention. The onshore yuan rate also fell to 6.5941, touching a five-year low and was at 6.5920 in late trading. The PBOC's China Foreign Exchange Trade System (CFETS) stressed that there was really no basis for yuan's depreciation.

Today's devaluation resulted in suspension of the stock market for the second time this week. The ‘circuit breaker’ mechanism also had to be brought in on Monday when the CSI 300 Index recoded a 7 per cent sell off. PBoC's fixing today has caused both regional currencies and stock markets to tumble. Investors worry that lowering the yuan would lead to devaluation of currencies by China’s trading partners as yuan devaluation will pressurize other Asian countries to lower the value of their currencies in order to stay competitive. Highlighting the market fear Sim Moh Siong, FX strategist for Bank of Singapore, added weakening of other currencies in response to yuan’s devaluation will lead to greater volatility.

Also, lower yuan will make commodities priced in U.S. dollars more expensive for Chinese buyers. Emand would be hurt in the process causing prices to slip and deflationary pressures to further build up. Commodity prices will remain depressed.

As yuan continues to fall more and more investors will pull capital out from China to park it at overseas market. This will cause a capital crunch in the Chinese financial system. In the process more pressure will be exerted in the yuan. The slide in yuan stands for trouble for China and this will enhance cash outflow. China's reserves fell by $87.2 billion in November to $3.44 trillion, the lowest level since February 2013. It marked the third-largest monthly drop on record.

The central bank's fixings this week lowered the value of yuan not only against the dollar but also other major currencies. It fell 3.5 per cent against the yen and 0.8 per cent against the euro.

The continuous devaluation of the yuan has led analysts to believe that lowering of currency is a method adopted by the central bank to help exports. ANZ economists Li-Gang Liu and Raymond Yeung feels "From a macroeconomic perspective, a weaker exchange rate is also consistent with monetary policy easing," They feel weakening of its currency will help China “induce some import inflation as the down trend of crude prices intensifies. China is the largest net oil importer”.

The offshore yuan swayed sharply from a 0.3 per cent gain to a 0.7 per cent loss raising speculation of central bank intervention. Uncertainty over the PBoC’s objective dominated the markets. Sue Trinh, head of Asia foreign-exchange strategy at Royal Bank of Canada in Hong Kong feels “China isn’t communicating its policy intentions in a clear manner. It is sending confusing signals to the market. And it’s disappointing that their communication policy is less than transparent.”
Several economists like Zhou Hao have failed to understand the rationale behind the market movements this week. Singapore-based Oversea-Chinese Banking Corporation (OCBC) said markets were clueless about “where the PBOC boundary is at the current stage".

Some other economists seem to have a little more clarity on the central bank’s purose. Kenix Lai, a foreign-exchange analyst at Bank of East Asia Ltd noted “The PBOC is intentionally guiding the yuan weaker by cutting the fixings, as it wants to allow the currency to reflect the weak fundamentals and help the economy.”

Whatever be the purpose, the free fall of the yuan definitely paves way for further depreciation. ANZ bank expects the central bank’s action to "create one-way expectation of RMB depreciation, propelling capital flight and leading to significant financial instability".
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